The Diamond Crisis

I was prepared to write my next big issue for 2015, number 5, but this week's news in the diamond business has diverted my attention.  Conditions have reached the boiling point, and the future is foggier than ever.

Without repeating all the details that I assume most concerned people have already learned, let's look at the upshot.  (A well done update is this week's column by Edahn Golan, issued just before the latest twist.  Look at his column at http://edahngolan.com/how-sightholders-take-care-of-business-a-market-report/)  In essence, the pipeline is stuffed with diamonds.  Some sightholders have been borrowing to buy goods, but using cash flow from under-priced sales to fund investments in other, more profitable ventures.  But many of those ventures have turned sour, and there have been some bankruptcies.  Apparently, there are many dealers under great pressure, and the market is seizing up as there is fear about selling anyone.  While I do not know the details, there have been a couple of suicides.  The banks have moved further away from financing the industry, if that is possible at this point.  Sales are down everywhere in the world, and there has to be some concern now about panic selling.

De Beers announced publicly that sightholder may defer purchases as long as to the end of the year, and maybe further.  The majority of the July sight was refused by sightholders, as they were overstocked and no doubt under severe financial pressure.  Part of the thinking, I am sure, was in response to the sudden collapse of the Shanghai stock market, with many stock falling by the maximum allowed, 10%.  Diamond sales in China have been down for some time, but this might mean a further downturn as Chinese consumers pull back.

I think I understate the severity of the current crisis.  There has been a lot of pain, and it is certain that the business will be seeing a lot more in the weeks and months to come.

If we take a macro view, the current mess does not come as a shock.  Let's look at some key aspects of the diamond market.

• Everyone wants to see prices stay stable, and rise, even if slowly.  This is unique to diamonds, and is a legacy of the De Beers monopoly.  For over 100 years, De Beers had worked to create and maintain the image of value in diamonds, even though diamonds have no particularly inherent quality that makes them exempt from the normal variances that come with economic cycles.  Nevertheless, as it became an established fact, all stakeholders relied on that to expand and build the business.  De Beers no longer leads in that way.
• That worked out fine, so long as the monopoly continued.  With the exception of the scare in the late 1970s, when even De Beers took advantage of skyrocketing prices until the bubble burst, the elite club of sightholders became wealthy.  De Beers did great, the banks supported the concept of controlled growth, and worldwide sales and inventories expanded.
• The threat of expulsion kept the pipeline full.  De Beers made sure to politely remind their sightholders that failure to abide by their rules could mean expulsion from the club.  As the major sightholders developed global business, they too needed to be assured that every five weeks they would be getting their allocation, even if that meant buying and flipping boxes when sales slowed and they did not need all the goods.  The banks obliged.
• Then the deal changed.  De Beers stuck to their process even as they could no longer dominate the world diamond business.  It worked for a while, as other producers rode De Beers' coattails and mimicked the sightholder process.  Producers understood the rationale for sights - you need to move all the goods - run of mine - to maintain profits, if not viability, at the mines.  This thinking was extended by making the process for getting approved as a sightholder far more onerous.  It instilled fear of losing allocations, but the producers introduced tenders to move more goods, and the whole process was undermined.
• The Great Recession brought problems, but also low interest rates and the BRICS!  It was a party for a while, and greed kicked in full bore.  Volume in Asia rose steadily, as the economies of China and India boomed.  Many companies overbought rough in order to ride prices higher.  Sales to Russians, Chinese, Middle Easterners, and Brazilians boomed.  
• Suddenly, the party has ended.  Every emerging market has turned down, the banks have bailed out (there is not a single major bank financing the industry in New York today, for example), and the sightholders have hit a wall.

Everyone is to blame here.  De Beers' objective now is to move as much goods as possible at ever higher prices.  The sightholder process has continued, even though they are no longer a monopoly, because the sightholders bent to the rules, believing that it all still works.  It doesn't.

Today, while there are no absolutes, the dangers are clear.  De Beers made a calculated move in allowing deferments.  They know that lowering prices might stimulate some sales, but will also lower the value of huge inventories held downstream.  Polished prices might (probably would) decline further, only making the problem worse.  Pricing may be less the problem than there simply being too much merchandise available.  The hope is that with severely curtailed sights, supply will come more into balance with demand by year end.

If that happens, all to the good.  But the reality is that the sightholder process is unsuited in a multi-polar world that is undergoing profound societal and commercial changes.  Sightholders will have to change their buying methods if they are to survive.